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In bankruptcy, prepare for worst

Many find Chapter 11 a dead end

By Judith Messina

Historically, Chapter 11 has been a safe harbor for companies struggling to stay alive in the face of crushing costs. Restaurateur Frederick Lesort was seeking such a harbor for his tony Frederick’s Madison when he filed last April. He hoped to renegotiate an expensive lease and attract new customers, some of them from other struggling eateries, says his lawyer, Anne Penachio.

It wasn’t to be: High costs and newly frugal diners stymied the Mediterranean restaurant’s recovery. The doors closed for good last month. “He had to make a decision,” says Ms. Penachio. “Did he really want to put good money in that location—or cut his losses?”

Chances of emerging are remote

Welcome to chapter 11, Great Recession style.

With credit markets moribund and debtors facing strict new bankruptcy rules, Chapter 11 has increasingly become a dead end for small and middle-market companies. As the New York economy continues to skid south, accountants and lawyers say a company’s chance of emerging from Chapter 11 is remote. Most companies end up liquidating or, if they’re lucky, finding a buyer.

“Banks are not lending to troubled companies based on stories of how they’re going to get better,” says Jeffrey Sutton, national director of corporate recovery services for accounting firm CBIZ Mahoney Cohen. “If you can’t restructure with the loans you have, you’re faced with a bankruptcy that is doomed to failure.”

The changed Chapter 11 environment has forced accountants who usually rely on bankruptcy work in a recession to find other sources of revenue.

Though the number of bankruptcies is up, the fact that so few companies emerge from the process means more clients simply are disappearing.

Consider these numbers: In June 2009, the latest month for which data are available, 192 businesses filed for Chapter 11 in the Southern District of New York, more than five times the number that filed in June 2008.

Nationally, of 209 companies that filed for Chapter 11 between 2006 and 2009 and are no longer in bankruptcy, fewer than half emerged successfully; the rest liquidated, merged or were sold, according to New Generation Research.

Specialists estimate that today only one in 10 companies emerges whole from bankruptcy. Lawyer Stephen Kass says that for every Chapter 11 case he takes on, he interviews 10 potential clients whose chances of getting out of bankruptcy are dim.

Even being picky about his clients doesn’t ensure a successful Chapter 11 process: “It’s getting harder and harder,” he says. “You could do all the right things, and your client [still] fails.”

For one thing, the current credit squeeze is forcing firms to make a do-or-die decision earlier in the process. Not only is it tough to get new money, but existing vendors and lenders are loath to cut bankrupt companies any slack, fearing they’ll dig themselves into a deeper hole as they spend money in a last-ditch effort to stay alive.

Tougher rules

“Lenders are sharpening their knives on Day One,” says Howard Brownstein of turnaround firm Nachman Hays Brownstein. “Upon the earliest indication that a credit is going south, the lenders are much more apt to yank the chain and yank it hard.”

Exacerbating the credit squeeze are new bankruptcy rules enacted in 2005 that leave less discretion to judges and require companies to pay some debts that in the past were considered unsecured, such as bills from vendors.

“It’s a huge hurdle,” says Michael Atkinson, a managing director with risk consulting firm Protiviti. “Companies now have to get a lot more financing.”

Faced with tough new regulations, unforgiving creditors and parsimonious consumers, many companies convert their Chapter 11 filings to Chapter 7 and liquidate. Some, after discovering they can’t emerge from Chapter 11, move to cancel the filing and shut down or try to regroup outside the costly bankruptcy process.

A way out

A few, more fortunate companies find a buyer, as did Broad Street Advisors, a commercial real estate brokerage, which filed for Chapter 11 last December and recently sold its assets to East-West Real Estate Advisors.

Similarly, Manhattan’s Diet Channel Network, a diet-education Web site that went bankrupt in August 2008 with $1.3 million in liabilities, last fall was sold to a couple of former board members for $255,000.

But for most companies struggling to emerge from bankruptcy in one piece, experts don’t expect help any time soon.

“While there are glimmers of hope for high-profile companies, for small and midmarket companies it depends on how much debt they have and whether they’re fulfilling a market need,” says Mr. Brownstein. “I think it will stay bleak for a while.”

LUCKY FEW

A HANDFUL OF COMPANIES are still able to emerge from Chapter 11 bankruptcy. A few get government help, such as too-big-to-fail General Motors and the politically favored New York Racing Association.

Small companies that beat the odds are rare, but those that don’t need financing have a long leg up. SKM Gourmet Products filed for Chapter 11 in March 2007 and successfully emerged later that year, according to bankruptcy court documents.

The Queens-based pasta maker didn’t need financing, just a chance to settle burdensome litigation. SKM’s lawyer, Gerard DiConza, says the judge in the case told him that it was the first successful small company reorganization he’d seen since new bankruptcy rules went into effect two years before. Chances are the judge hasn’t seen many since.

“Three years ago, there was more hope of reorganization,” says Mr. DiConza. “Today, the calls I get from clients are calls asking, ‘What is the quickest way to shut down?’ “

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We are two affiliated law firms providing Bankruptcy, Tax, Business and Corporate Legal Services

Law Offices of Stephen B. Kass, P.C.

For more than 15 years the Law Offices of Stephen B. Kass, P.C. has offered experienced legal counseling in the areas of Bankruptcy (Chapter 7, Chapter 13 for Consumers and Chapter 11 Reorganization filings for Businesses with high tax debt as well as Chapter 11 filings for individuals with substantial liabilities, Tax Litigation and Agreements with the Internal Revenue Service [IRS] and Debt Negotiations with Creditors).

We are one of the few firms in New York that deals with the IRS, NYS, the United Stated Attorneys and Attorney Generals on tax matters on a regular basis.

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Working with clients in Small/Local Business & Corporate matters including Business Exit Strategy, Purchase and Sale of Small Business, Corporate Compliance, and Shareholder Disputes.